ALIGNING EXPECTATION WITH POSSIBILITY

Why is the world at large so often “surprised” when the materially impossible doesn’t happen?

In economics, the consensus line – a narrative shared by government, business and, for the most part, the general public – is that the economy will carry on growing as we shift from climate-harming fossil fuels to cleaner alternatives such as wind and solar power. This process, boosted by advances in technology, will increase our leisure time, and give us more money to spend on discretionary (non-essential) products and services.

In reality, none of this can happen, yet we keep being “surprised” when it doesn’t.

Renewable energy cannot replicate all of the economic value hitherto sourced from oil, natural gas and coal, and the supposedly “green” credentials of renewables are, to put it mildly, highly debatable. EVs can’t replace all of the world’s ICE-powered vehicles on a like-for-like basis.

As top-line prosperity decreases, and the costs of energy-intensive necessities carry on rising, the affordability of discretionary products and services will decline. A string of sectors and activities widely regarded as highly growth-capable are, in reality, heading into relentless contraction.

This same process of affordability compression is going to undermine the ability of the household and corporate sectors to service, let alone honour, their enormous debt and quasi-debt obligations.

In short, the much-cherished consensus view of the economic future is founded on a series of material impossibilities.

Accordingly, anticipated “growth” in discretionary sectors like travel, leisure, hospitality, the media and entertainment won’t happen, and these sectors will, instead, start to contract. The same thing will happen to “tech”, undermining faith in the concept of inexhaustible, profitable growth driven by the relentless advance of innovation.

Property prices will fall as affordability is compressed, and the authorities will come under increasing pressure to cut rates and resume the creation (“printing”) of money. There will be another “banking crisis”, except that, this time around, systemic risk won’t emerge first in banks themselves, but from within parts of the NBFI sector (the non-bank financial intermediaries known colloquially as “shadow banks”).

Meanwhile, the authorities will come under ever-increasing pressure to explain why people are getting poorer in supposedly “growing” economies (and good luck with that one).

These considerations take us into the purposes of projection. If you’re convinced that economic catastrophe looms, there may seem little point in forecasting disparities in performance.

If, though, you believe that we might muddle through – that ‘things are never as good as we hope, or as bad as we fear’– then there’s much to be gained by calling out the distinctions between consensus expectation and material possibility, and using these discrepancies to frame our choices.

As consumers, voters, employers, employees and investors, times might be hard, but there’s little merit in making things worse than they need to be by exposing ourselves to the worst disappointments that are looming for the consensus.

How, then, can we draw these distinctions between the generally-expected and the materially-possible?

‘Man bites dog’

The unexpected is newsworthy, whilst the widely anticipated usually isn’t. Snow in Wales during December barely makes the news, but snow in July would be the stuff of headlines.

The headline article in the Financial Times on 3^rd April referenced declining sales of electric vehicles by Tesla and Chinese competitor BYD. These falling sales, said the FT, had “stoke[d] scepticism over speed of electric shift”, raising “fears for long-term growth” in the EV sector.

Two days later, the Times ran a similar story about EVs losing market share in the United Kingdom.

This is newsworthy because it runs contrary to consensus expectations, which are that sales of EVs will continue to grow to a point at which all cars and lorries powered by internal combustion engines will have been replaced.

My first reaction to this story, and perhaps yours too, was to wonder why anyone was surprised by this at all. We have long known that replacing all, or even most, of the world’s two billion cars and commercial vehicles with battery-powered alternatives has never been within the bounds of practical possibility.

It’s more than doubtful that we have the raw materials to produce this many EVs and, even if we did, we don’t, and won’t, have the energy required to access and process these materials, or to power an EV fleet of this size. EVs have only advanced as far as they have because of generous government incentives, and these can’t be sustained in perpetuity.

The consensus narrative about EVs is, of course, a branch of the wider assumption that we can replace all of the energy value hitherto sourced from fossil fuels with cleaner alternatives from renewable energy sources, principally wind and solar power, thereby averting environmental disaster at no cost to standards of living.

This, again, isn’t feasible. Other considerations aside, the far lesser energy density of renewables alone makes this impossible.

Technology can’t get us past these material obstacles, because technology can’t create raw materials that don’t exist, or repeal the laws of thermodynamics that determine the characteristics of different sources of energy.

To assume otherwise is to accede to a collective hubris which contends that human ingenuity can make us masters of the universe when, in reality, the potential scope of technological advance is strictly circumscribed, by finite material resources and by the laws of physics.

Rather than pursue the theme of energy impossibility – that renewables aren’t a like-for-like replacement for oil, natural gas and coal, and that neither renewables nor EVs deserve their supposedly hyper-positive environmental credentials – my thoughts turned in another direction.

How many other non-surprising “surprises” are we going to encounter as the economy inflects from growth into contraction, and as the costs of energy-intensive necessities carry on rising?

Why, in essence, is the world at large so “surprised” when the impossible doesn’t happen?

The basis of myth

According to conventional economics, we live in a world of infinite possibility, and we owe it all to the human contrivance of money.

No material shortage need ever put the brakes on growth. If something is in short supply, its price will rise. As well as discouraging consumption, price rises incentivize producers to bring new supply to the market, and encourage both substitution (where consumers switch to buying something else instead) and innovation (where we find new ways of supplying or substituting for the product in question).

This theory can sometimes work in practice, in markets for things like coffee. If the price of coffee rises, some consumers will buy tea instead. High prices encourage suppliers of coffee to increase planting and harvesting, perhaps growing coffee on land that previously grew something else. We might find improved methods of growing and processing coffee beans.

These, though – whisper it who dares – are mechanisms with limited reach.

Another way to put this is that this money-only economic theory might well have worked in an agrarian society of the kind that was universal in 1776, when Adam Smith penned The Wealth of Nations, the founding treatise of classical economics. Smith can’t be criticised for not knowing what would happen after another Scot, James Watt, gave society the first truly efficient machine for converting heat into work.

Ironically, this also happened in 1776.

Both the agrarian and the industrial economies are energy systems, as all economies are. But the similarity ends there. In agrarian economies, energy is sourced from human and animal labour, and from the nutritional energy which makes this labour possible. Even supplemented by some rudimentary wind and water power, this system was never going to expand the global population ten-fold, or create severe environmental and ecological hazard.

Unlike the principles of classical economic theory, the economy itself has moved on since 1776. The vast majority of the energy used by the system now comes, not from human or animal labour, but from oil, natural gas and coal, which continue to account for four-fifths of primary energy supply. Hydroelectric and geothermal power make useful but limited contributions, as does nuclear, though the latter has never – thus far – lived up to some of the more outlandish promises made on its behalf when we first harnessed “the mighty atom”.

Energy, though, is fundamentally different from commodities like coffee and tea. If coffee is too expensive for economies or consumers to buy, they are no worse off for not having it – they simply spend their money on something else.

But a household or an economy deprived of energy is materially poorer, because everything that we produce or consume is a function of the energy available to the system.

In short, the principles applicable to the working of an agrarian economy don’t work in an industrial society, because they don’t apply to energy.

Anyone who understands this fundamental difference possesses the ace-in-the-hole for out-forecasting those by whom this critical distinction hasn’t been recognised. This takes us into the dynamics of material economic prosperity.

An understanding of process

Essentially, the industrial economy works by using energy to convert natural resources into material products and services. This is a two-part equation, with the production process operating in tandem with the dissipative conversion of energy from dense into diffuse forms. This productive-dissipative process becomes a dissipative-landfill system when we choose to accelerate the rate at which products are relinquished and replaced.

Importantly, if we switch to energy inputs of lesser density, the dissipative process is truncated, the parallel productive process is correspondingly shortened, and the economy gets smaller. This, ultimately, is why renewables cannot replace all of the economic value hitherto sourced from oil, gas and coal.

The friction drag on this dynamic is the cost of energy, a cost which isn’t financial (because we can always create money), but material. Because putting energy to use requires the creation, operation, maintenance and replacement of a material infrastructure – and nothing material can be created or operated without energy – the supply of energy is a process in which we have to use energy in order to get energy.

Put another way, “whenever energy is accessed for our use, some of this energy is always consumed in the access process”. This “consumed in access” component is known in Surplus Energy Economics as the Energy Cost of Energy, abbreviated ECoE.

If ECoEs fall, any given quantity of energy yields a larger quantity of ex-cost economic value. If ECoEs rise, this material economic value decreases. Prosperity is defined in SEE as the financial corollary of the surplus (ex-ECoE) energy available to the system.

Money plays a humbler role in the economy than that claimed for it by classical economics. Money can’t overcome physical limits, convert natural resource scarcity into surplus, or power infinite economic growth on a finite planet.

Rather, money functions as a medium of exchange, meaning that the owner of money has an exercisable claim on the output of the material economy.

This is fine so long as monetary claims are matched by corresponding quantities of material products and services available for exchange. Prices, as the monetary values ascribed to material products and services, act as the interface between the material economy and its monetary proxy, and comparative analysis of these two economies is by far the best way of working out what inflation really is.

This is why SEEDS uses its own conception of systemic inflation, RRCI (the Realised Rate of Comprehensive Inflation).

The application of principle

The recognition of the economy as an energy system more or less compels us to adopt the conceptual necessity of two economies. One of these is the “real economy” of material products and services, and the other is the parallel “financial economy” of money, transactions and credit.

From this process, certain observations about our current predicament and future prospects can be reached, and most of them run counter to the consensus narrative.

First, the economy has started to shrink, because ECoEs are rising at a far more rapid pace than can conceivably be matched, let alone overtaken, by increases in the supply of total (pre-ECoE) energy – indeed, the likelihood now is that aggregate energy supply will decrease, because renewables are likely to be added at a rate which falls short of the pace at which fossil fuel availability decreases.

There is most unlikely to be any improvement in the rate of conversion which governs the amount of pre-cost economic output generated from each unit of energy available to the system. Accordingly, output will decrease, whilst the difference between output and prosperity will widen as a result of rising ECoEs.

The energy-intensive nature of so many necessities dictates that the costs of essentials will carry on rising. Investment in new and replacement productive capacity can be expected to decrease, for two main reasons. First, opportunities for profitable investment are contracting.

Second, a little-noted but critical trend has undermined the process of investment itself.

Historically, investors’ returns on their capital came in the form of cash dividends and coupons, supplemented by capital appreciation driven by rises in anticipated forward income streams.

Now, though, yield – the rate of cash returns – has been very severely depressed, and investors’ returns come mainly in the paper form of capital gains, and these, in aggregate, can never be monetised. Once the “everything bubble” in asset prices bursts, returns on invested capital will fall back to the (very low) levels provided by yield alone.

This trend needs to be seen in the context of rising financial stress and worsening exposure. Stress can be measured by comparing movements over time in the material and monetary economies, remembering that a tendency towards equilibrium is inherent in the claims relationship between the two economies.

Quantitative exposure has, of course, increased dramatically, with both debt and broader quasi-debt outgrowing the economy, even when the latter is calibrated as GDP, a measure artificially-inflated by the credit effect on transactional activity.

In essence, a radical correction in the relationship between financial stock and material economic prosperity has been hard-wired into the system.

Knowing this, however, makes it no less important that we understand that discretionary sectors are going to be the main victims of a process of leveraged compression, as the costs of essentials rise at the same time as the material economy itself is contracting.

Fig. 1

THE COMING FINANCIAL CRASH

One question, above all others, has dominated our recent discussions here. This is the issue of whether the financial system will fracture as the underlying “real” or material economy inflects from growth into contraction.

Has some kind of chaotic reset – either contractionary or hyperinflationary – become inevitable? Are we – to put it colloquially – heading into a re-run of the Wall Street crash and the ensuing Great Depression?

The answer is that we are. Only two outcomes remain possible. One is a cascade of defaults and asset price crashes, and the other is a full-on resort to money-creation, resulting in an uncontrollable surge in inflation.

The likelihood is that the latter will be tried, but will fail to prevent the former.

The financial system has been set up to fail.

To understand why, we need to follow trends in the relationship between the two economies – the “real economy” of material products and services, and the parallel “financial economy” of money, transactions and credit.

The road of folly

One of the main characteristics of financial markets is that they endeavour to price the future. Left to their own devices, they might well have done this effectively, pricing in a gradual and manageable contraction in the underlying economy.

Investors would have become increasingly risk-averse, switching from discretionaries into staples, and pulling back from non-sovereign credit exposure.

These are things that investors can still do, of course, but it’s no longer possible for this to happen in an orderly, gradual manner.

The system, though, far from being left to fulfil its functions of price-discovery and putting a price on risk, has been subjected to massive distortion, and compelled to price a future which cannot happen.

Decision-makers have followed a false mantra which decrees that monetary stimulus can deliver indefinite material economic expansion, a mechanism which cannot work in an economy butting up against energy, resource and environmental limits.

When the Western economies started to experience deceleration – “secular stagnation” – in the 1990s, this could have been traced to its causation in energy trends, and policies could have been adjusted accordingly.

Instead, the response was a resort to credit liberalisation. When this led, inevitably, to the global financial crisis of 2008-09, the authorities adopted ultra-loose monetary policies, with the twin aims of crisis-management and economic stimulus. The results were the inflation of a massive “everything bubble” in asset prices, and a surge in debt, much of it outside the regulated banking sector.

This has been an on-steroids re-run of the follies of the “roaring twenties”, made much more toxic by the unanchored fiat currency system that didn’t exist back in the 1920s.

This time, moreover, we’ve taken things so far that the essential principles of market capitalism have been abrogated. Markets are no longer left free to set prices and calibrate risk, whilst investors can no longer earn a real (above-inflation) income return on their capital.

We don’t yet know what kind of post-capitalist system will be ushered in by economic contraction, but no such system will be able to sustain a financial structure based on ever-expanding credit, designed to disguise economic contraction, and often used for gambling on successive failed themes.

The hard reality of inflexion

The history of the modern economy is one of gradual deceleration from growth into contraction.

This began in the advanced economies of the West, whose high levels of complexity render them especially sensitive to the force driving the global economic downturn, which is the relentless rise in ECoEs (the Energy Costs of Energy).

By virtue of the lower systemic upkeep costs which come with lesser complexity, most EM (emerging market) economies have, until recently, carried on expanding, but they, too, are now reaching the point on the ECoE curve at which the economy inflects from growth into involuntary de-growth.

These processes are illustrated in Fig. 1, where total and per capita prosperity are indexed to 2023, and compared with trend ECoEs.

Fig. 1

This means that we are now at, or very near to, the global economy’s point of inflexion. Economic “growth” is still being reported, but most of this is the cosmetic effect of pouring ever more public and private credit into the system, and counting the spending of this money as “activity”. There’s not much value in recording, say, “growth” of 2% when the government has to run an 8% fiscal deficit to achieve it.

If you’ve been visiting this site for any length of time, you’ll know how the “real economy” of material products and services operates, and how prosperity is determined by the supply, value and cost of energy, operating within a broader context that includes non-energy natural resources and the limits of the tolerance envelope of the environment.

You’ll also know some, at least, of what lies ahead. Just as prosperity is going into decline, so the real costs of energy-intensive necessities are rising. Sectors supplying discretionary (non-essential) products and services to consumers have entered a process of worsening affordability compression.

Sales of smartphones have already inflected and, despite lavish support from taxpayers, the pace of adoption of EVs seems to be decelerating markedly. The news media and hospitality are amongst the sectors now entering discretionary contraction. Social media, entertainment and travel are amongst the industries closing in on this contractionary moment.

Discretionary contraction is going to create enormous job losses, but the longer-term outlook is for increasing displacement of machinery with human labour. This time around, we’re not likely to see armies of cloth-capped working men queueing up for government handouts but, rather, a haemorrhaging of middle-ranking technical, professional and specialist posts as businesses cut costs and streamline their operations.

We know that this process of inflexion is happening, and we know why. The large and complex modern economy was built on abundant low-cost energy from coal, oil and natural gas. The costs of these fossil fuels are rising relentlessly because we have, quite naturally, used lowest-cost resources first, leaving costlier alternatives for a ‘later’ which has now arrived.

This process has been subjected to extensive investigation by many people around the world and, here at Surplus Energy Economics, has been modelled using SEEDS.

We have no equal-value alternative to fossil fuel energy, meaning that the material (ECoE) cost of energy will carry on rising, and the economy will contract. The costs of energy-intensive necessities will carry on rising, investment in new and replacement productive capacity will shrink and, most importantly of all, the ability of households to afford discretionaries – the things that people might want, but don’t need – will be subject to relentless contraction.

This doesn’t just mean that households will have to get by without various non-essentials hitherto taken very largely for granted. It also means that they will find it increasingly hard to ‘keep up the payments’ on everything from secured and unsecured credit to subscriptions and staged-payment purchases.

In an economy shaped by energy, there’s no bottomless well of household financial resources, and any attempt to create one using ultra-loose monetary policies can only lead to the hyper-inflationary destruction of the purchasing power value of money.

The outlook for the material and financial economies is quite clear, and is pictured in Fig. 2.

Structurally, the departure of the “financial economy” (of money, transactions and credit) from the underlying “real economy” (of material products and services) has introduced enormous disequilibrium pressure into the system (Fig. 2C), pressure that has been rising even as the aggregates of debt and broader liability exposure have been escalating (Fig. 2D).

Fig. 2

What next?

Within our general understanding of economic and financial causation, two big questions remain to be answered. First, what’s going to happen to domestic and international politics as the public, previously promised perpetual material betterment, awakes to the reality of deteriorating prosperity, narrowing choices and worsening insecurity?

Second, can the financial system, in its present form, survive the inflexion of the material economy from growth into contraction? The short answer to this question is that it can’t, and the task ahead is to redesign the financial system for a smaller, supportive role in a shrinking economy.

The political issue requires a discussion all to itself, but we can already see popular dissatisfaction finding voice in the rise of authoritarian populism. If people are assured that growth is continuing, whilst their own circumstances are getting steadily worse, what conclusions can they be expected to draw?

They might conclude that all the talk about growth is fiction, but they’re likelier to suspect that, whilst growth is indeed continuing, all, and more, of the benefits of this growth are being cornered by a small, dishonest and self-serving minority.  

If the current rise of populism seems like an echo of the years between 1918 and 1939, there are some other striking similarities between what’s taking place now and what happened in those inter-war years.

Whilst history never repeats itself, there are recurring patterns, and Tim Watkins is to be commended for reminding us of the main economic feature of the inter-war years. In essence, the coal-based economy was decelerating into contraction at a time when the oil economy wasn’t – quite – ready to replace it.

Now, the oil economy itself is inflecting but, this time around, there’s no new, higher-value energy source waiting in the wings to take over.

The cresting of the coal economy, and the gap that intervened before oil was ready to take over, might sound like a minor glitch, a temporary, if irritating, snag with time-phasing. But it was anything but minor for those who had to live through it.

First, in October 1929, came the Wall Street crash, an event made so serious by the run-up of prices (and euphoria) during the reckless years of the “roaring twenties”.

Next came the miseries of the ten-year Great Depression. The hardship (and unfairness) of the depression years played right into the hands of demagogues, including Hitler, Mussolini, and the nationalist-expansionist faction in Imperial Japan. The rest, as the saying goes, “is history” – a war that killed between 70 and 85 million people, followed by a recovery powered by oil.

How far are these patterns likely to recur?

These are matters of behavioural factors intersecting with economic trends, and it’s useful to reflect for a moment on how a superior intelligence, watching from the depths of space, might view our current predicament.

This intelligence would marvel at the behaviour of homo idioticus which, already experiencing severe environmental and ecological degradation and, conceivably, heading into a Holocene extinction event, carries on driving, flying, mining, consuming, polluting and landfilling as though nothing other than consumption matters at all.

This superior intelligence might find humour in our efforts to deny reality with endless exercises in financial gimmickry, and might wonder – since there are no investment analysts on the Moon, or credit rating agencies on Mars – who exactly we’re trying to impress or deceive.

With the important difference of using an untethered fiat currency system, we’ve been re-running the “roaring twenties” on an enormous scale. The narratives used to ‘justify’ hyper-inflated stock and property prices become increasingly implausible, the latest one being predicated on AI putting to rights everything that human intelligence has got wrong.

We’ll have to go through a GFCII event, this time on a scale that no amount of monetary gimmickry can buy off. Then we’ll have to build a new financial system, just as individual countries have been compelled to do after the hyperinflationary destruction of their currencies.

WINNERS AND LOSERS

It’s been said that “horse-sense” is the innate wisdom that prevents horses from putting bets on human beings.

I’m not a betting man myself, but we can all see the benefits that must accrue from knowing the outcome of a race before any wagers have even been placed. Those benefits can be greater still if all the mainstream pundits carry on tipping the wrong result.

This is the position that we’re now in, and my aim here is to explain, in brief, why this is.

The long-running contest between the economic orthodoxy and the energy-based alternative is ‘all over bar the shouting’ (though there will be plenty of that), and the energy argument has won.

Anyone who understands the economy as an energy system has an inside track over anyone – the majority – who still believes that economics is the study of money.

Thus understood, asset markets are partying at the end of growth. Governments, corporations and investors are planning for a future that cannot happen. The public is increasingly angry with politicians who promise what cannot possibly be delivered.

The background, at its briefest, is that conventional economics insists that the economy can be explained and understood in terms of money alone. If this were true, it would mean that there need never be any end to economic expansion.

The opponents of this orthodoxy, though they may disagree amongst themselves on many other things, share the insight that, on the contrary, ‘infinite economic growth on a finite planet’ is an impossibility, and that prosperity is a material concept, traceable to the characteristics and behaviour of energy, natural resources and the environment.

The nature of growth

The battleground here is growth. If the orthodoxy was right, growth should be continuing but, in any meaningful sense, it is not. Momentum – the trend-line of the economy – should be rising or, at the very least, constant, but it has long been heading downwards.

Such meagre “growth” as is still being reported is cosmetic, being faked by the reckless injection of credit into the system.

If, in order to deliver one dollar, euro, yen or pound of growth, we have to create more than one dollar, euro, yen or pound of new credit, part of any reported growth is being faked. Using the narrow definition of formal debt, each dollar of global growth has, over the past twenty years, been accompanied by $3.20 of net new borrowing.

On a broader basis, including the credit assets of the NBFI (“shadow banking”) system for which data is incomplete, the ratio of credit expansion to growth is probably well in excess of 7:1.

This, of course, cannot continue in perpetuity. The end result must be default, and a loss of faith in the value of fiat money.

These divergences are illustrated in Fig. 1, from which it will be apparent that the gap between debt and GDP has widened to the point of unsustainability, with average “growth” of 3.5% over the past twenty years manufactured by borrowing at an annual average rate of 11% of GDP. The situation with regard to broader financial liabilities is even worse.

Fig. 1

‘The powers that be’ – my preferred term is the high command – have been reduced to excuse-mongering along the lines of ‘the dog ate my homework’.

Growth would have been robust, we’re told, if it hadn’t been for a European war and a global pandemic. The ‘cost of living crisis’ is a purely temporary phenomenon. They know how to fix it. A combination of technology and financial gimmickry will restore the economy to growth. If you didn’t buy Big Data, or ultra-cheap renewable energy, or ubiquitous EVs, as a fix for a faltering economy, try a spoonful of AI.

Growth in the United States has, we’re informed, had nothing to do with the vast injection of liquidity through escalating, out-of-control government borrowing. Even the moribund British economy can achieve “growth” through cutting a tax burden that is, in fact, continuing to rise. China can shrug off the discovery that much of the growth of modern times turns out to have flowed from a gigantic real estate ponzi which is now unwinding.

Won’t get fooled again?

It seems clear beyond peradventure that growing numbers of people around the world aren’t buying the excuses. They’re getting worse off, not better off, and, increasingly, they know it.

We’re seeing this in increasingly fractious and aggressive politics. Governments are becoming steadily more authoritarian ahead of challenges that they sense, even if the causation continues to elude them.

There are two explanations on offer for the worsening prosperity, and the deteriorating economic security, of the average or “ordinary” person, meaning anyone lacking substantial wealth and the right connections.

It turns out that both of these explanations are correct, and that, taken together, they explain the predicament of the majority.

The first explanation is worsening inequality, an accelerating flow of wealth from the many to the few. Intentionally or not, this has been driven by policies, particularly those designed to sustain a semblance of “growth” through extreme monetary gimmickry.

The second is that the economy itself, far from continuing to expand, is in the process of inflecting from growth into contraction.

Put both of these together and the result is that a self-serving minority is cornering an increasing share of a shrinking economy.

These conditions are becoming increasingly dangerous. Economic hardship, and perceptions of worsening unfairness, are two of the four classic causes of social instability. The others are a leadership isolated from reality, and the promise of an alternative vision which says that things can get better if we adopt a different basis for the organisation of society.

Western society now emphatically ticks three of these four boxes. Hardship is worsening, and trust in the fairness of distribution is sinking. The high command displays every sign of not knowing what’s going on with the economy, or of how this is affecting the ‘ordinary’ person.

We may not have a new ideology propounded by a latter-day Paine, Marx, Lenin or Mao, but the political mainstream is utterly detached from reality and possibility, leaving a vacuum increasingly occupied by populists.

Being in the know

Having the inside track on the economy, anyone who understands the material dynamics of energy, resources and the environment has pretty good visibility on what happens next.

As material prosperity contracts, and the costs of energy-intensive necessities carry on rising, a series of sectors supplying discretionary (non-essential) products and services reach the point of inflexion. We have now, as outlined in the previous article, entered a mountain range of discretionary peaks – peak smartphone (which has already happened), peak media (which is unfolding now), peak hospitality, peak travel, peak gadget, peak property price, and many, many more.

We can also anticipate the counter-productive responses to these trends. Suppliers of discretionaries will scramble to provide credit to would-be but impoverished customers. Governments and central banks will try – as they’ve been trying for many years – to fix the faltering economy by lending and printing ever more liquidity into the system. Asset prices will reach giddy heights from which they’ll be dragged down by the forces of material economic gravity.

Poorer but better?

We are, by now, very well aware of the threats posed by environmental and ecological degradation. We’ve deluded ourselves into the persuasion that these threats can be tamed without material economic sacrifice, and that neither the environment nor resource constraints can stem the expansion of the human economic enterprise.

All of these assumptions are turning out to be mistaken.

Many thinkers have urged the need for voluntary economic de-growth, but these counsels have never won out over consumerism. The outlook, becoming clearer by the day, is for involuntary de-growth.

We no longer need to focus our efforts very largely on persuasion. Facts and dynamics have taken over. Our primary need now is to model, quantify and project the trends towards a discretionary-led economic contraction that is already under way.

Within an increasing emphasis here on modelled trends, some of the main parameters analysed by SEEDS are shown in Fig. 2. The “growth” supposedly delivered in GDP has been widely at variance with the trend in material prosperity. Since 2000, extreme and worsening disequilibrium has emerged between the “financial” and the underlying “real” economies, reaching a point at which financial fracture has become inescapable.

Systemic inflation, used in the calculation of “real growth”, has long been severely understated, whilst the progression towards discretionary contraction has become unmistakable.

For those who understand what’s really happening, having this knowledge can be positive, as we look ahead to what the corporations and governments of the future will look like.

Fig. 2

WORSENING STRESSES IN AN INFLECTING ECONOMY

As almost everyone must have noticed by now, economic and broader affairs are in a strange state of uneasy limbo. The economy certainly hasn’t ‘collapsed’, as some pundits have long been predicting, but neither is it growing, in any meaningful sense.

Conditions are characterised by worsening hardship and widening inequality, and this, compounded by suspicion and mistrust, is making itself felt in increasingly fractious domestic politics. A disturbing feedback loop ties internal political discontent into the stresses of dysfunctional international relations.

There’s a growing feeling that ‘things aren’t working’, and that the continuing affluence of a minority is in striking contrast with the deteriorating economic circumstances (and worsening insecurity) of the majority.

One can almost sense a collective holding of breath as we wait to see ‘what happens next’.

I cannot escape a conviction that very few people really understand that what we’re experiencing now isn’t some kind of temporary economic stasis, but the cusp of a fundamental change for which societies are not prepared.

Accordingly, the aim here is to use the SEEDS model to make sense of this unquiet calm, and to provide some insights into what actually does ‘happen next’.

In summary, hardship and stress at the level of the micro – that is, of the household and the individual – are about to extend into disorder at the level of the macro. We’re heading very rapidly into “peak almost everything”.

The qualifying “almost” is necessary, and we need to know how we can best navigate the turbulence that is now about to commence. We need to work out which activities – which sources of income, employment, revenue, profit and value – are likely to buck the generalised trend of disorderly decline.

The two-stage inflexion

Stated at its simplest, growth in material economic prosperity has long been decelerating towards a point at which the economy as a whole inflects from expansion into contraction.

Some years ago, this decelerating rate of growth fell below the rate at which population numbers have been continuing to increase. Since 2019, the world’s average person has been getting gradually poorer, even as aggregate prosperity has carried on edging upwards.

These trends are illustrated in Fig. 1. Though aggregate material prosperity hasn’t – quite – reached its zenith (Fig. 1A), this aggregate is now growing at a rate lower than the (decelerating) pace at which the population continues to expand (1B).

Accordingly, the per capita point of inflexion (1C) occurred some years before the point of aggregate inflexion (1A).

We’re now very near indeed to the moment at which prior growth in the overall size of the economy goes into reverse. This is when the Big Numbers – the size of product and service markets, revenues and profits in the business sector, employment, resources available to governments, and the quantity of sustainable credit – all start to get smaller.

Fig. 1

The segmental progression is pictured in Fig. 1D. What comes next is a succession of peaks, including peak gadget, peak media, peak travel, peak hospitality and peak property price. We’re also likely to reach peak supportable credit and, in some cases, to discover that we’ve gone a long way past peak national cohesion.

This doesn’t mean that everything hits a peak, because generalised contraction will create opportunities for expansion in alternatives. For instance, local amenities might enjoy a revival as long-distance travel reverts to being the preserve of an affluent few. Likewise, peak property price might redress a balance of opportunity that has been loaded against the young for far too long.

The reason why

If you ask officialdom – or even if you don’t – you’re likely to be told that the economy is ticking over pretty well, and would have been doing even better if it hadn’t been for the sheer bad luck of running into a global pandemic and a European war in quick succession.

Some have alleged that these events have been engineered in order to disguise economic deterioration, and/or to cloak a grab for wealth and power by a self-serving minority. There’s no solid evidence for – or against – these claims, but the pandemic and the war have certainly thrown a mantle of confusion over what’s really been happening to the economy and the financial system.

Our best recourse is to objective analysis of economic and financial fundamentals.

Properly defined, the economy is a system for the supply of material products and services to society.

Thus seen, the economy is an energy system, not a financial one. Nothing that has any economic value at all can be provided without the use of energy. Money has no intrinsic worth, but commands value only as an “exercisable claim” on the output of the material economy. We know that the large and complex economy of today has been built on an abundance of low-cost energy sourced from oil, natural gas and coal.

The factor which does most to determine economic prosperity is the material cost of energy supply. If delivering 100 units of energy requires using the equivalent of 99 units in order to make it available, the game is scarcely worth the candle.

If, on the other hand, 100 energy units can be delivered at a cost of only 1 energy unit, this activity is immensely productive of economic value.

Energy is never ‘free’, but comes at a cost measurable in terms of the proportion of accessed energy needed to create and sustain the infrastructure required for energy supply. This cost is known here as the Energy Cost of Energy, abbreviated ECoE.

Globally, trend ECoEs reached their low point in the quarter-century after the Second World War, explaining the super-rapid economic growth enjoyed in that period.

Since then, ECoEs have trended upwards because of the depletion of fossil fuel resources. Oil, gas and coal remain abundant, but have been getting progressively costlier to access. Renewables, with their lesser energy densities, cannot take us back to a halcyon age of ultra-cheap energy.

Being unable – or unwilling – to face the implications of rising ECoEs, we’ve long been playing a game of “let’s pretend” with the economy. Because GDP is a measure of financial transactions – and not of material economic value – we can create a simulacrum of “growth” by pouring ever-increasing amounts of liquidity into the system.

Nobody needed credit deregulation, QE or sub-zero real interest rates in the 1945-70 period, because low ECoEs were driving the economy along, ‘very nicely, thank you’, without recourse to financial manipulation. Only as the economy has decelerated have we adopted various forms of monetary gimmickry in order to pretend that the illogical promise of ‘infinite economic growth on a finite planet’ remains a valid expectation.

Using the concepts of two economies, energy-determined prosperity and money as claim, SEEDS models the trajectories of financial and material economic trends. As can be seen in Fig. 2, ECoEs have been rising relentlessly, and surplus (ex-cost) energy supply has been decelerating towards contraction. Per capita surplus energy has inflected into decline, and prosperity per capita has taken on a downwards trajectory.

Fig. 2

Accompanying this, financial stresses have been worsening. Debt has massively outgrown reported GDP as credit expansion has been deployed to create purely cosmetic “growth” (Fig. 3A). It required annual borrowing of more than 11% of GDP to sustain illusory “growth” at a supposed average of 3.5% (3B) over the past twenty years. Broader liabilities have exploded (3C), and the state of disequilibrium between the financial system and the underlying material economy has become extreme (3D).

When we apply the extent of disequilibrium stress pictured in Fig. 3D to the quantum of exposure shown in Fig. 3C, the end result – a massive and disorderly financial correction – becomes a foregone conclusion.

With the exception of the stress measure illustrated in 3D, we don’t need access to the SEEDS system to work out that this ‘bigger-than-the-GFC correction’ cannot long be delayed, and will happen at the moment when the delusory promise of perpetual economic growth loses the last shreds of its credibility.

Fig. 3

Matters of coping

As we saw in Fig. 1D, what happens from here is that top-line economic output deteriorates whilst the real costs of energy-intensive necessities carry on rising. Some national equivalents of Fig 1D are shown in Fig. 4, where, in addition to the United States, China and Britain, I thought readers might be interested in how SEEDS interprets the Russian economy.

The net effect of these trends is severe compression of the affordability of discretionary (non-essential) products and services. This, it should be stressed, is already happening, though ‘the powers that be’ are, with only limited success, managing to present this as a temporary ‘cost of living crisis’ rather than as the structural phenomenon that it really is.

I’m reasonably sanguine that the public can cope – that is to say, they can survive the loss of many products and services hitherto taken for granted. After all, the term discretionary describes things that aren’t necessities. Most people didn’t have smartphones until comparatively recently, so peak smartphone – which has already happened – is manageable. We may not relish the prospect of local rather than long-distance holidays, but most of us will make the best of it. We’ll get by with less information media and less entertainment, survive the loss of social media, and come to terms with peak tech reasonably well.

Coping with peak car really involves, for many Westerners, a reversion to the one-car household that was the norm until relatively recent times, and would be made a lot easier if governments were to rediscover the merits of investing in trains, trams and buses. The over-inflation of property prices hasn’t added to the utility that people derive from having somewhere to live, and has had adverse affordability consequences both for the young and for those on low incomes.

Barry Cooper has published a valuable and timely book on the lifestyle implications of discretionary contraction, stressing that one probable consequence will be that centralised, “top-down” organisations (think multinational corporations and top-heavy government departments) will wither away, their places being taken by more localised, “bottom up” alternatives.

Unfortunately, what we might call “micro-coping” won’t translate well at the macro level. Individuals may manage without various non-essential products and services, but what happens to people employed in supplying these discretionaries, the debt and equity capital invested in them, and the contributions that discretionary sectors have hitherto made to government resources?

Because of the financial gimmickry described above, many industries have become over-capitalised, meaning that the amount of financial capital attached to any given quantity of material productive capacity has become excessive.

Businesses can be expected to adapt to contractionary forces, even where their leaders don’t, as yet, recognise where these forces are coming from. Beyond market contraction and the loss of pricing power, developing trends pose two specific challenges to business.

First, unit costs can be expected to rise as market volumes contract. This is what happens when any given amount of fixed costs has to be spread across a diminishing number of customers.

Second, the risk of loss of critical mass arises as necessary components or services cease to be available, or can only be obtained at prohibitively high cost. These are compound vulnerabilities which will exacerbate the stresses of volumetric contraction.

Within and beyond the general motif of cost reduction, businesses will be compelled to opt for simplification, which will come in two distinct forms.

The first is simplification of product, typified by a decrease in the number of different products offered to the customer. The second is simplification of process, where activities are streamlined, commonization of components is progressed, and non-vital stages in the provision of goods and services are eliminated.

The latter will involve de-layering, and this will shape the way in which job losses take place. In considering the employment consequences of discretionary contraction, we need to set aside long-ago monochrome images of despairing, hungry, cloth-capped working men queueing up for unemployment benefits.

The demand for manual labour is likely to increase as the costs of mechanisation are pushed up by tightening energy supplies. This time around, the brunt of rising unemployment will be borne by those professional, well-paid managerial and technical employees whose posts are likely to fall victim to de-layering.

All of these processes are going to change the balance of forces in civil society, such that politics becomes ever more unpredictable.

A point that cannot be emphasised too strongly is that economic deterioration, with all of its attendant stresses, is moving from the predicted to the experienced.

Some discretionary sectors are already contracting. Politics is already becoming dysfunctional. The hardship being presented officially as a temporary problem is, in reality, a foretaste of the shape of things to come – or, perhaps more aptly, the shape of things to go.

Fig. 4

EXPLORING THE TRANSACTIONAL CURVE

Why has the global economy become credit-addicted, and why has a post-capitalist kleptocracy replaced the market economy? Why is the much-vaunted transition to EVs decelerating, and why are the costs of renewable energy development rising? Can we really achieve nil-net-cost net zero, switching to more climate-friendly energy sources without becoming poorer in the process?

The answers to these and many other questions lie in economics, but not, as we shall see, in the way that economic issues are customarily presented to the public, and debated by decision-makers in business and government.

We can’t explain any of these trends by reference to money alone, but need to bring the material, and the laws of physics, into the equation.

 

Monetary experience, material substance

It’s understandable that the material gets lost in an economic system experienced in monetary form, Contracts of employment, for instance, don’t state that the employer will provide food, accommodation and transport in exchange for labour. Instead, the employee receives money with which to buy these necessities, hopefully with a margin left over for the purchase of discretionary (non-essential) products and services.

Whether we’re earning or spending, lending or borrowing, or investing for the future, we experience (and inter-act with) the economy in monetary form, but the prosperity of society, and the ways in which economic resources are allocated, are determined by the material.

In short, energy and materials are the substance of an economic system that is experienced financially.

What we’re going to discuss here is how the material has shaped the monetary over time, and how we can normalise the transactional curve to the underlying materiality of the economy.

For those who like some of their conclusions up front, the consensus narrative of a future in which everyone drives around in an EV powered by cheap and abundant clean energy isn’t going to happen, because it contravenes the limits of the material.

The rise of the post-capitalist kleptocracy can be traced to the sacrifice of market principles on the altar of a promised – but impossible – indefinite continuity of growth.

Whole sectors of the economy are heading into contraction and, in some cases, outright disappearance. We are witnessing massive malinvestment as capital is allocated to ‘growth’ sectors which have no real prospects of expansion. Some economies are far closer to the cliff-edge than has yet been realised.

Many of us would like to know how economic and broader trends are likely to unfold. Monetary trajectories alone cannot tell us this, but the harmonising of the monetary to the material can do so.

 

The basics – of materials and money

Effective interpretation of the economy requires the application of a concept wholly unknown in orthodox economics. This is the concept of two economies – a “real economy” of material products and services, and a parallel “financial economy” of money, transactions and credit. I introduced this concept in my 2013 book Life After Growth.

This concept is a necessity because, contrary to the insistence of the orthodoxy, the economy isn’t entirely, or even primarily, a financial system. Having no intrinsic worth, money has value only in terms of the material products and services for which it can be exchanged (the concept of money as claim).

By excluding the material, the economics orthodoxy manages to promise ‘infinite growth on a finite planet’, something which, in the words of Kenneth E. Boulding, co-founder of general systems theory, could only be believed by “a madman or an economist”.

The orthodoxy has various ingenious work-arounds for the finality of resources, but no amount of incentive, financial stimulus, substitution or innovation can supply something which does not exist in nature.

To be quite clear about this, we can lend money into existence, and central bankers can create it at a key-stroke, but we can’t similarly conjure energy or raw materials out of the ether. Natural resources are, by definition, finite in character.

When we think about natural resources, we tend to put fossil fuels, minerals, water and productive land into this category. But the environment, too, is a finite natural resource – it’s finite in its tolerance, meaning its ability to absorb the effects of human economic activity.

We know that the material exists. A long-ago writer said that we discover the reality of the material in infancy, when our first hesitant steps bring us into painful collision with the furniture. The human mind may struggle to grasp the concept of infinity, but we should have no trouble with comprehending the finite.

My efforts over the past decade have been concentrated on exploring, explaining and calibrating the “real” or material economy, and using it to benchmark the “financial” economy of monetary transactions.

We know how this “real economy” works, and it’s a matter of energy, raw materials and physics – not money.

 

Understanding the material

I don’t intend to go into technicalities here, but the biggest challenge of the SEEDS project has been to translate the substance of the material into the language of the monetary. The whole aim of the project has been to link the financial to the material.

Stated at its simplest, the physical economy functions by using energy to convert raw materials into products and services. The latter emphatically belong in this category, because no service can be provided without material assets, such as vehicles for delivering packages, and a network for the supply of on-line services.

We can no more render the economy ‘immaterial’ by displacing goods with services than we can somehow “de-couple” the economy from the use of energy. The latter is impossible because the economy IS an energy system.

As regular readers may know – but new visitors might not, and this simply can’t be reiterated too often – there are two distinct characteristics of the material economy which can guide us to effective interpretation.

The first is that energy is never “free”, and the second is that the critical characteristic of energy is its density, something which can be likened, for convenience, to the power-to-weight equation as it affects the performance of vehicles.

Energy is never “free”, because it cannot be put to use without a physical infrastructure. Oil and gas aren’t “free” because they exist beneath our territory, and renewables aren’t “free” just because the sun shines and the wind blows. We need wind turbines, solar panels, power storage systems and distribution grids for the harnessing of renewables, just as surely as we need wells, mines, pipelines and processing plants for the supply of oil, natural gas or coal.

This infrastructure is physical, meaning that its creation, operation, maintenance and replacement require raw materials. These raw materials cannot be accessed or processed without the use of energy.

Accordingly, putting energy to work is an ‘in-out’ process, in which, whenever energy is accessed for our use, some of this energy is always consumed in the access process. This ‘consumed in access’ component is known in Surplus Energy Economics as the Energy Cost of Energy, abbreviated ECoE.

 

The productive equation

The second material precept – the critical importance of energy density – can be explained by reference to the dual nature of the economic production process. When energy is used to convert raw materials into products, so energy itself is converted from a dense to a diffuse state.

These two processes are inseparably linked, so we can’t have the one without the other. In this productive-dissipative equation, if we shorten or truncate the dissipative process by reducing the density of energy inputs to the system, we correspondingly shorten the productive process, resulting in a smaller economy.

It’s regrettable, but undeniable, that renewables are less dense than fossil fuels. Transitioning to renewables may have environmental benefits – though even this claim needs to be treated with caution – but an economy powered by less energy-dense renewable energy must be smaller than an economy powered by more energy-dense oil, gas and coal.

The environmental (as well as the supposed economic) merits of renewables need to be heavily qualified, because a system based on less dense energy needs a correspondingly larger physical supply infrastructure. This in turn means an expanded need for raw materials, and this is likely to have many adverse environmental and ecological consequences.

Moreover, the accessing and processing of these raw materials increases the need for energy inputs. Indeed, the term “renewable” is questionable, because the only energy source capable of supplying everything from concrete and steel to copper, lithium and cobalt, in the quantities needed for transition, is legacy energy sourced from fossil fuels.

The energy-productive process thus described does not operate in a vacuum. Other critical factors include the quantity and quality of mineral resources and food-productive land. As mentioned above, a further critical resource is the natural environment, meaning the capability of the environment to absorb the effects of economic activity. Just like iron ore or arable land, environmental tolerance is a finite resource.

 

Not to infinity

The foregoing should frame our understanding of the sheer impossibility of ‘infinite economic growth on a finite planet’.

As well as being ultimately finite in character, natural resources interact with the economy in a specific way. Faced with choices, we always, and quite naturally, use the lowest-cost resource first, setting aside costlier alternatives for later. As this process progresses, it results in depletion, whereby each new resource becomes costlier than the one it replaces.

With energy, this results in a distinctive ECoE curve or parabola, illustrated in Fig. 1A.

Taking petroleum as an example, ECoEs declined as the industry explored the globe in search of larger, lower-cost reserves; as the expansion of the oil business yielded economies of scale; and as the technology used in the industry improved.

Eventually, though, the potential benefits of scale and geographic reach were exhausted, and depletion took over as the primary driver of ECoEs, which then turned upwards. There are strict limits to how far technological advance can offset this rising trend, because the potential of technology is limited by the physical characteristics of the resource.

Here’s an issue that we need to look fairly and squarely in the face. The dramatic growth in the size and complexity of the modern industrial economy is a direct consequence of harnessing the vast amounts of low-cost energy contained in the planet’s reserves of fossil fuels. Nothing like it had ever happened before.

Its continuity is entirely dependent on the discovery of alternatives, and these must be at least as energy-dense as oil, gas and coal.

We cannot rule out the discovery of a new energy source matching or exceeding the density of fossil fuels, but there are two observations that are extremely pertinent to our situation.

First, renewables aren’t going to provide energy of the necessary density. Second, we are rapidly running out of time for such a discovery, because the trend ECoEs of fossil fuels are rising very rapidly indeed.

Though we don’t have the data needed to track the ECoE curve back to the early years of the twentieth century and beyond, we can say two things, with considerable confidence, about the nadir of the fossil fuel ECoE curve.

The first is that it probably occurred in the quarter-century after 1945. The second is that the trend ECoE of fossil fuels was probably well below 1% at its lowest point. From 2% in 1980, and 4.2% in 2000, all-sources trend ECoE has already broken the 10% barrier, and is likely to reach 18% by 2040.

In the absence of some spectacular scientific discovery, trend ECoEs must carry on rising, and material prosperity must inflect from growth into contraction. This is shown in Fig. 1, in which stylized long-run ECoE and prosperity curves are paired with more recent trends for which data is available.

 

Fig. 1

We need to be in no doubt that, if this is what’s happening to the “real” economy of material products and services, the parallel “financial” economy cannot wander off in a different direction, because money is validated only by our ability to exchange it for the material.

As extreme disequilibrium emerges between the ‘two economies’, we cannot compel the material to conform to the financial, because the exchange value connection between them doesn’t operate in that direction.

 

From the material to the monetary

I said we wouldn’t go into technicalities in this discussion but, in outline, SEEDS analysis plots two distinct curves, globally, and for each of the 29 national economies covered by the model. The prosperity curve of the “real” economy, though material in character, is presented in monetary terms for the purposes of benchmarking and comparison with the “financial” curve.

As you may know, GDP is a measure of transactional activity, not material economic output. As such, it is capable of distortion, not least by the injection of large amounts of credit into the system. Between 2002 and 2022, and stated at constant values, GDP increased by $83tn, or 103%, whilst debt expanded by $266tn, or 209%.

These are not discrete series, because the sole purpose of taking on credit is to spend it, meaning that growth in debt necessarily drives increases, unrelated to value, in the transactional activities measured as GDP. We can calculate that each dollar of reported “growth” between 2002 and 2022 was accompanied – and made possible – by a $3.20 increase in debt. Put another way, we had to borrow at an annual average rate of 11% of GDP to deliver annual average “growth” of 3.5% between those years.

Additionally, of course, no allowance is made for ECoE in the measurement of GDP. Trying to measure the economy without including energy in general, and ECoE in particular, is like staging Hamlet without the Prince.

The artificial ‘credit effect’ is something that happens over time, and this makes the analytical value of reported GDP equivocal. We probably can accept that $164tn is a reasonably accurate snapshot of transactional activity in 2022, but we can’t accept that this was an increase of 103% (real) over the previous twenty years, because of the distorting effects of credit creation over time.

Accordingly, if we want to know the real rate of change in the economy in past years, we need to retrofit (“harmonise”) transactional activity to the curve of the material. This is illustrated, on a global basis, in Fig. 2.

Using this same technique, we can project the economy forwards along the curve of material prosperity, and allocate output to the three critical segments of essentials, discretionary (non-essential) consumption, and capital investment in new and replacement productive capacity.

 

Conclusions

If we don’t mind stretching the relationship between the financial and the material, we can carry on, perhaps for a while longer yet, creating additional transactional activity by pouring new credit into the system. This describes the simulacrum of “growth” that economies have been reporting in the age of subsidised money.

But this doesn’t mean that extra economic value has been delivered, and the consequence of this process is that liabilities will rise to a point at which the likelihood of their ever being honoured ‘for value’ ceases to be credible. Market vertigo is going to be one of the main factors that triggers the coming financial crash.

The general conclusions of SEE analysis of transactional trends are wholly consistent with what we know about the economy from the standpoint of material analysis. Just as rising ECoEs are driving down the supply and ex-cost economic value of energy, so the real costs of energy-intensive necessities are being pushed upwards.

This can be expected to undercut returns on invested capital, such that capital investment decreases. As this happens, and as asset markets slump, the effect will be to expose enormous malinvestment. Calibrating the scope of this malinvestment, and determining where it has occurred, is perfectly feasible, but not in the compass of this article.

The affordability of discretionary products and services will be subject to leveraged compression, a process already visible in economies worst exposed to the “cost of living crisis”.

Discretionary compression will, of course, have financial as well as economic effects, undermining the ability of the household sector to carry its massively-expanded burden of financial commitments.

Where the economy itself is concerned, though, the process of discretionary compression is the trend to watch as material conditions continue to deteriorate.

 

Tim Morgan

 

Fig. 2

TOWARDS A ‘NEW ECONOMICS’

One discovery really can change everything. What we are now discovering is that the economy – the system which supplies material products and services to society – has stopped growing, and has started to contract.

What this discovery means is that everything affected by economic conditions – including finance, politics, and the balance of forces within society – is going to change in ways that are only now starting to become apparent.

This is isn’t a difficult discovery or, even remotely, a new one. It has been known since at least as far back as 1972, when the authors of The Limits to Growth gave us a remarkably prescient picture of how events would pan out.

Far from being a hard concept to grasp, the reality is the simple impossibility of infinite economic expansion on a finite planet. That energy is at the core of everything material – which of necessity includes the economy – is day-one knowledge for every student of biology, chemistry or physics.

What falsified the gloomy predictions of Thomas Malthus was the omission of energy from his calculus. He didn’t, and arguably couldn’t, have foreseen how the harnessing of energy from coal, oil and natural gas was going to transform everything, including the production of food.

We cannot conclude, as an absolute certainty, that the fading out of the fossil fuel impetus is going to compress society back to a pre-industrial scale and simplicity.

But we are entitled to conclude that the economy will contract unless and until a successor form of energy is discovered. That successor energy must match or exceed the energy density of fossil fuels. Neither renewables nor – in our current state of knowledge – nuclear power can deliver on that requirement.

The idea that the economy is entirely under our control is nothing more than formalised hubris. The “dismal science” of economics may or may not be dismal, but it certainly isn’t a science. The “laws” of economics are nothing more than behavioural observations about the human artefact of money, and are in no way analogous to the laws of the physical sciences.

We are inching, painfully slowly, towards a new conception of economics. This will be built on a combination of disciplines. Thermodynamics will answer material questions, such as the creation, operation, maintenance and replacement of the productive system. Behavioural analysis will address questions of human interaction within the monetary parallel of the material economic system.

There’s a prior analogy for this duality, though in that instance the disciplines drew apart rather than converging. This dates from a time when the study of the material was known as “natural philosophy”, as distinct from the “moral philosophy” of studying behavioural issues in society. From this duality emerged the separate concepts of “natural sciences” and philosophy as the study of the human condition.

Economics, which has to try to balance the relationships between the “natural” (science) and the human (“philosophy”), has managed, in its orthodox or classical form, to get this duality hopelessly mixed up.

No apology need be made for reiterating that the banking system cannot lend energy or other resources into existence, and that central bankers can’t conjure them from the ether. When we pore over the latest puffs of smoke from the Federal Reserve, or mull over the promises and pronouncements made by politicians, what we’re considering is finance, which isn’t remotely the same thing as economics.

However painful and protracted the process may be, fact always wins out over fiction.

The facts of the economy are that we use energy to extract raw materials and convert them into products and services. This, like so much else, is a duality. Just as energy is used to convert materials into products, so energy itself is converted from a dense to a diffuse form. This diffuse form is waste heat, and, when fossil fuels are the dense energy input to the system, this waste heat contains climate-harming gases.

These productive and diffusive systems are inseparable, and of corresponding length. If we switch to energy inputs of lesser density, we truncate (shorten) the dissipative process. This means that the productive sequence, too, is shortened, resulting in a smaller economy.

This applies just as much to services as it does to products. We cannot deliver parcels without a vehicle, or provide technological services without hardware. In both cases, energy is required to operate the hardware, as well as to create it and, in due course, replace it.

Economic supply is thus a productive-dissipative equation. It becomes a dissipative-landfill system when we choose to accelerate the cycle of creation, disposal and replacement.

Hitherto, this dissipative-landfill model, which is the basis of consumerism, has been feasible because we’ve had the material abundance of the energy needed to make it work, and the assumed abundance of the ability of the environment to absorb the by-products of this behaviour.

Time is being called on the dissipative-landfill model, and this call is coming from two directions.

It is surely clear beyond dispute that we are testing, and probably over-taxing, the absorption tolerances of the natural environment.

Meanwhile, our past exploitation of the easiest, lowest-cost sources of fossil fuel energy has put us onto a decline path, where each new source of oil, gas or coal has a lesser ex-cost value than the one that it replaces.

My approach to the duality of economics has been to propose the concept of “two economies”. One of these is the “real economy” of material products and services, a system driven by energy. The other is the parallel “financial economy” of money, transactions and credit.

SEEDS – the Surplus Energy Economics Data System – interprets and projects the economy on the basis of this duality. It reveals that numerous economic problems are traceable to imbalances in the relationship between the “two economies” of the material and the monetary.

The linkage between the two is hierarchical. At least in theory, the “real” economy could exist without its financial counterpart. It is at least possible for us to operate the material economy on the basis of sharing, barter or centralised allocation.

But the “financial” economy cannot exist without its material corollary. Having no intrinsic worth, money commands value only as an exercisable “claim” on the material products and services for which it can be exchanged.

Beyond efficiency of exchange, what the financial economy brings to the party is temporal distinction. Money can be spent now (“flow”), or it can be set aside for the future (“stock”). We measure the stock of the material in days or weeks of forward demand (or, in the case of electricity, in minutes or seconds). With the stock component of money, we can enter into transactions extending decades into the future.

Critically, though, the choice between flow and stock does not change the fundamental monetary characteristic of exchange value as “claim”. We can make promises ranging far into the future, but we cannot honour them if, at the due date, there is an insufficiency of material products and services required for the process of exchange.

As a human artefact, money is vulnerable to fakery, even if there is no malign intent.

In the world of fine art, fakery is deliberate if it involves knocking up a picture at home and trying to pass it off on an unsuspecting buyer as a Rembrandt. Fakery can be unintentional if we’ve always believed – mistakenly – that the painting that’s been hanging in the drawing room for generations is a genuine Gainsborough.

The same applies to financial commitments. When we enter into transactions whose closure will not occur until decades have passed, the best we can do is to either calculate – or simply assume – that, when that day comes, the material wherewithal required will be available.

The financial economy, in its stock function of assets and liabilities, is based on a set of assumptions which are – in most cases inadvertently – false. The idea that the economy is an infinitely-expanding system powered by money is a fallacy. The economy is, in reality, an energy system, limited by the finality of resource value and the finality of environmental tolerance.

This, ultimately, is why we’ve been using fakery – perhaps innocent, perhaps intentional – to keep the financial system from toppling over. We tried to counter the deceleration (“secular stagnation”) of the 1990s by ramping up the supply of credit to the system. When this led, not to the nirvana of accelerating material growth, but to the crisis of 2008-09, we opted to turbocharge the credit flow with monetary gimmickry.

The result has been the simultaneous creation of an “everything bubble” in asset prices (which is destined to burst) and a liabilities mountain (which must collapse because it cannot possibly be honoured).

This has turned into a version of the old childhood game of “pass the parcel”. We don’t know when the music will stop, but we do know that it will. What we need to find, in the rubble of the detonated asset bubble and the debris of the exploded credit mountain, is a way of understanding the economy, not as we might like it to be, but as it really is.

 

Tim Morgan

 

FINANCIALIZATION, ANOMALY AND RISK IN AN INFLECTING ECONOMY

It’s been said that, when events turn fast, furious and frightening, and civilians are panicking, the professionals get ever cooler and more calmly calculating.

If this is so, we’ll need to be very professional indeed in 2024.

One of our most serious challenges is that economic and financial forces are pulling in opposite directions. Transactional activity, and the aggregates of assets and liabilities, are continuing to expand, even as the underlying material economy is inflecting from growth into contraction.

Our interest, in this first article of 2024, is in the process of financialization which is driving this divergence. We need to know why parallel forces are driving us to a state of simultaneous affluence and destitution, and why trends increasingly obvious to investors in energy are still invisible to those investing in almost everything else.

Just one consequence of this disconnect is the ludicrous proposition that fossil fuel assets – without which we cannot possibly transition to renewables – are somehow “stranded” and valueless, when the reality is the polar opposite of this exercise in absurdity.

Where wealth is concerned, capital theory tells us that, as the authorities continue to prop up the flow side of the economy by wrecking the stock side of the equation, the resort to ever-looser monetary policies should result in continuing rises in asset prices.

At the same time, though, a point will soon be reached at which the sheer magnitude of our mountainous debt and quasi-debt liabilities induces confidence-snapping vertigo.

Soaring asset prices are, logically, going to make us rich, then, just as escalating liabilities are going to land us in the poor-house. Since logic baulks at the concept of affluent bankruptcy, it’s hard to avoid the conclusion that we’re going to end up owning vast amounts of worthless money.

We’re going to need every analytical skill at our disposal, and every piece of innovative thinking we can lay our hands on, to come out on the right side of this progression.

Meanwhile, in the markets, and indeed in industry, we’re seeing the emergence of a remarkable anomaly.

On the one hand, investors, and energy industry decision-makers too, are reluctantly coming to terms with a material reality, which is that renewables aren’t going to deliver the much-vaunted abundance of low-cost energy after all.

We’re not going to get rich, then, by investing in wind, solar or hydrogen companies, and the development of these energy sources is going to be much costlier, and far less profitable, than had hitherto been assumed. Indeed, it’s hard to escape the conclusion that transition to renewables, if it’s going to happen at all, is going to need subsidy, which can only come from consumers, taxpayers, or both.

On the other hand, though, nobody is yet making the connection from the suppliers to the users of energy. If renewable energy isn’t going to be cheap for those who produce it, neither can it power a tech-and-leisure utopia in which the broader market still believes.

Our need, as I see it, is to deepen our understanding of a series of complex dynamics – the material and the monetary in economics, flow-stock equations in finance, and the energy-prosperity relationship in the material economy.

So let’s get started.

 

What is financialization?

Technically speaking, the term “financialization” references growth in the absolute and proportionate size of the financial services sector of the economy, a process that carries with it increases in intermediation, and rises in debt-to-equity ratios in business. It’s a term used to describe the rise of ‘financial capitalism’, a variant of, or a successor to, the industrial capitalism of the past.

One can easily see why the term financialization is used pejoratively. Critics allege, for example, that the manufacture and sale of a car needs to be no more than a bilateral transaction between the manufacturer and the purchaser of the vehicle, and that both parties lose out through the unnecessary insertion, for profit, of financial intermediation into such transactions. A riposte to this might be that, without the availability of finance, the car could neither be made nor purchased at all.

The aim here, though, is to be analytical rather than judgemental.

Leaving the politics out of things, financialization has two primary effects. The first is the insertion of more transactional activity into the exchanging of any given quantity of material products and services. The second is that debts and quasi-debts (debt-equivalents) have to increase in order to fund this increased transactional activity or churn.

To emphasise – because this is critical to understanding – the analytical significance of financialization is that it increases transactional activity without adding material economic value. Why this matters will become apparent shortly.

Financialization has been moving on from the established definition of increasing the use of financial services, and hence of credit, within the economy. For example, when a person’s information is garnered for sale to advertisers, his or her data has been financialized. When our otherwise-unvalued time spent waiting to be served at a post office or a delicatessen is used as a marketing opportunity by putting a screen in front of us, that waiting time, too, has been financialized.

This extension of financialization feeds into a new business model. Historically, the aim of businesses has been to sell products or services to customers. Increasingly, this aim has shifted towards the development of streams of income, most commonly as ad-supported or subscription services. There has been a parallel rise in staged payment purchases – in shorthand, BNPL (buy-now, pay-later) – which is a process that comes nearer to the standard definition of financialization.

The streams-of-income model has carried over from the flow side of the financial equation to the stock side, which is what happens when such hypothecated revenue streams are capitalised.

This presents two specific challenges. First, this business model is likely to turn out to be far more fragile than has yet been recognised – ad spending and subscriptions are amongst the easiest savings possible for hard-pressed businesses and households.

Second, its failure could trigger interconnected detonations across the financial system.

Before we get into that, though, let’s remind ourselves about some little-known fundamentals of finance and, first, the economy itself.

 

Financialization in context

As you may know, there is an essential prerequisite for the effective understanding of finance and the economy.

This is the conceptual necessity of two economies.

One of these two economies is the “real economy” of material products and services, and the other is the parallel “financial economy” of money, transactions and credit.

We can, if we choose, stick to the old Flat Earth notion of a materially unconstrained economy, capable of perpetual expansion, and explicable in terms of money alone. But, in an age of increasingly apparent material and environmental boundaries, the classical immaterial straightjacket to economic thinking, with its assurances of infinite growth on a finite planet, is going the way of the dodo.

The material has arrived, in the sense that physical and environmental limitations are forcing themselves upon our unwilling attention. Environmental deterioration can’t be bought off with money. Central bankers can’t conjure low-cost energy, or high-density mineral resources, out of the ether.

It transpires that most processes – including inflation/deflation, asset price bubbles and liability-driven crises – are ultimately traceable to distortions within the relationship between these “two economies”.

As the fossil fuel impetus fades away, and with no real (as opposed to mistakenly suppositional) complete alternative in sight, the material “real” economy is inflecting from growth into contraction.

At the same time, the parallel financial economy has been expanding at an accelerating pace.

This divergence is dangerous, because it moves the system away from the fundamentally necessary equilibrium between the financial and the material.

This equilibrium is a necessity because, properly understood, money has no intrinsic worth, and its value resides entirely in its role as an exercisable claim on the material economy. If the aggregate of these claims outgrows the wherewithal to honour them, the resulting body of “excess claims” must be diluted or destroyed. We can try to push the restoration of equilibrium out into the future, but we can’t eliminate the dynamic.

Financialization, as we’re looking at it here, is driving this worsening disequilibrium because, as we’ve noted, it involves the attachment of additional financial transactional activity to any given quantity of material economic value in the form of goods or services.

The necessary accompaniments of this form of financialization are (a) the inflating and subsequent bursting of asset price bubbles, (b) the parallel accumulation and destruction of enormous financial liabilities, and (c) the monetary degradation that may attend efforts to prevent these reversions to equilibrium from playing out.

We cannot trace this process through conventional metrics, because, contrary to widespread misunderstanding, GDP is a measure, not of material economic output, but of transactional activity. Accordingly, financialization creates a comforting illusion of growth in ways that serve to disguise the real hazards of super-rapid liability and asset market expansion.

This is why we need to use our own tools and insights, based here on “two economies” and the SEEDS economic model.

 

A big anomaly

One of the skills we’re going to need going forward is an enhanced ability to spot internal contradictions.

One such anomaly is the divergence between the energy-supplying and the energy-consuming sides of the capital markets.

In energy supply, one myth remains intact, and one is now succumbing to reality.

The intact myth is that fossil fuel assets are somehow “stranded”, and of little or no value. As we shall see, this must be one of the daftest conclusions ever reached in investment analysis.

The myth that’s now succumbing to reality is the notion that renewable energy can only get less expensive over time.

This is where an anomaly of perceptions – a failure to link up the fortunes of energy suppliers with those of energy users – is coming to the fore.

Energy users don’t come any bigger, in simple financial terms, than the Big Seven tech stocks. These continue to storm ahead – their aggregate market value increased by about 75% in 2023, and now matches the combined market capitalisations of the Japanese, British, Chinese, French and Canadian exchanges.

But nobody seems to be asking the hard questions about what’s going to power tech activities (or anything else) in an energy-constrained future.

The almost universally-proffered answer is that Big Tech – and pretty much everything else – will be powered by cheap renewable energy. The only fly in this ointment is that renewables aren’t going to be cheap. Their lesser energy-densities, in comparison with fossil fuels, make this impossible.

Some people, though, are asking this question rather than simply assuming a comfortable answer to it. These are the people who manage, and invest in, the renewable energy supply sector of the market.

A little forensic analysis gives us a clue to this big anomaly that’s emerging in the financial markets, albeit as yet seemingly unnoticed by asset allocators.

As the always-insightful Goehring & Rozencwajg have pointed out, the prices of a host of renewable energy stocks – including Orsted, Nextera and Plug Power – have plunged from previously-exuberant highs, whilst the corporate appetite for investment in renewables projects has been decreasing markedly.

The stock price examples cited by G&R are not exceptions to an otherwise positive trend. On the contrary, as of mid-December, the S&P Global Clean Energy Index and the S&P Global Clean Energy Select Index had fallen by 21% and 28%, respectively, since the start of 2023. This contrasts very starkly indeed with a rise of about 25% in the S&P 500 itself over that same period.

To be clear about this, renewables development is still happening, but it’s turned into an uphill slog. Power prices have to rise to keep it viable, and subsidy may be the only way to stop the wheels from falling off.

Ultimately, business and domestic consumers will have to pay for that, either as customers or as taxpayers, because there’s nobody else who can. And, by definition, if people have to spend more on one thing, they have less to spend on something else.

 

The advance of non-cheap renewables

The underlying problem is that ‘cheap’ renewable energy is turning out not to be cheap after all. Some of us have never believed it would be.

For a start, cheap wind and solar power requires cheap fossil fuel energy to deliver all the steel, cement, copper, lithium, cobalt and other raw materials needed to build, operate, maintain and replace the system.

This linkage dictates that, if the material (ECoE) costs of fossil fuels are rising relentlessly, which they are, those of renewables cannot decrease. This linkage also makes the very idea of “stranded” or ‘valueless’ fossil fuel assets an absurdity.

To return to a point made earlier, the rationale informing the impossibility of cheap renewable energy is a straightforward matter of energy density. The densities of renewables are lower than those of fossil fuels, and technology can’t overturn the laws of physics in order to change this material relationship. The lower the density of an energy source is, the larger – the more material-intensive, and the more costly – the delivery infrastructure has to be.

The message clearly being taken on board by energy investors is that, contrary to what had previously been received wisdom, wind and solar power are not going to deliver enormous profits through the supply of ultra-cheap energy for sale at healthy margins to domestic and business customers.

Where investors in energy itself are concerned, then, this penny seems to have dropped. But, if renewables aren’t going to be highly-profitable or low-cost for those who supply them, what about those who use them?

Is it feasible that non-cheap energy can power us to an ultra-profitable tech and leisure nirvana?

Can consumers really become more prosperous when the material cost of the energy embedded in everything they buy carries on rising?

Somebody, somewhere, has got their wires crossed.

With that noted, let’s get back to financialization, and the disequilibrium between the “two economies”.

 

The credit engine

With financialization, of necessity, goes credit expansion. When seen through the prism of “two economies”, it’s readily apparent that there’s no other way of financing the churn.

Over the past twenty years – and stated in real (ex-inflation) terms in international PPP dollars – global debt has increased by $265 trillion, but this doesn’t include broader financial liabilities, such as those of “shadow banking” (the non-bank financial intermediary or NBFI sector).

Because of glaring gaps in the availability of data, we can only estimate growth in these broader liability aggregates, put here at about $320tn, which is almost certainly a pretty conservative calculation. Beyond this again lie rapid rises in the “gaps” in unfunded pension commitments, and the potential nightmare that is derivatives.

Global broad liabilities, then, have increased by about $585tn in real terms over twenty years. which is roughly 7X the expansion in reported real GDP (+$83tn).

That ratio, in itself, is wholly unsustainable. But the real sting in the tail here is that three-quarters of that supposed “growth” has been the cosmetic effect of financialization itself.

By backing out the growth-inflating “credit effect”, and deducting the first call on output made by the Energy Cost of Energy, SEEDS analysis reveals that world material economic prosperity increased by only $20.6tn (rather than $83tn) between 2002 and 2022. We should never forget that, as mentioned earlier, gross domestic product isn’t a measure of material economic output, but of financial transactions, which is a very different thing, and the creation of non-value-additive transactional activity is a necessary statistical product of financialization.

What the numbers tell us is that, in annual, inflation-adjusted terms, we have become, over twenty years, materially better off by less than $21tn, having ramped up our collective liabilities by getting on for $600tn.

We can see the sleight-of-hand of financialization in numerous instances. If IMF data published in October is confirmed by final outcomes, for example, the American economy, measured as real GDP, will have grown by about 2.1% in 2023. But the same data puts ‘general government net borrowing’ – the fiscal deficit – at 8.2% of GDP.

This means that about US$530bn of growth will have been bought with upwards of US$2.1tn of government borrowing, the latter confirmed by American public debt breaking the US$34tn barrier. This is even before we include increases in household and corporate debt (and, of course, in their NBFI and other quasi-debt exposures).

It’s an often-remarked fact that the American consumer has been extremely resilient in recent times, comfortably out-spending inflation – but it’s hard to see how he or she could have been anything less than resilient, when being handed this much additional liquidity, borrowed on his or her behalf by the government.

 

Another anomaly – the concept of wealthy bankruptcy

Part of the contradiction in the financialized morass in which we have become entangled is that the same factors that seem ‘good’ for asset prices are simultaneously ‘bad’ for economic stability.

Within capital theory, there’s a valid debate to be had about which – interest rates or liquidity? – is the primary driver of asset prices. A reasonable conclusion might be that asset prices are a function of the supply and the cost of capital, because these are linked – an increase in the quantity of money (a rise in liquidity) is consistent with a decrease in its price (interest rates).

On this basis, expansionary fiscal and monetary policies point towards continuing rises in the prices of stocks and property. To prop up GDP, and pretend to deliver “growth”, the authorities will have to carry on driving public (and, for that matter, private) debt upwards.

Some observers think that the central banks’ real motivation in pushing rates upwards was to create headroom for cutting them again when exigencies require. The logic of ever-rising public debt points towards both lower rates (to keep government debt servicing affordable) and a reversion from QT to QE, to create enough debt-rollover liquidity in the system and, perhaps, to fund public borrowing if other sources fail.

So far, so good. But the same dynamics that seem destined to make us wealthy (by driving asset prices upwards) also seem destined to put us in a Marshalsea debtors’ gaol (by pushing debt and quasi-debt to ever more stratospheric levels).

We are, then, going to be both (a) rich beyond the dreams of avarice, and simultaneously (b) bankrupt, defined as having liabilities that we can’t possibly honour. (We can’t, collectively, pay off the debts by selling the assets, because any amount of asset sales requires a matching quantity of purchases).

 

A twisting road to reality

Just as surely as nature abhors a vacuum, logic abhors the concept of wealthy bankruptcy.

There are two ways – though they are not mutually exclusive – in which this contradiction can be resolved. First, the mountain of liabilities could collapse, taking asset values down with it. The second is that runaway money-creation could destroy the purchasing power of currencies.

We might, then, find ourselves the possessors of vast amounts of worthless money. If this is how things turn out, financialization, in all of its various forms, will have been ‘a road to ruin, paved with bad incentives’.

Before it quite gets to this, though, some other processes can be expected to kick in. These are best considered pictorially, using charts sourced from SEEDS.

The first chart shows how rapidly debts and broader liabilities have been outstripping even GDP, let alone underlying prosperity.

At the same time, risk itself has been rising as the disequilibrium between the real and the financial economies has become progressively more extreme (Fig. 1B).

In short, the quantum of liabilities has been rising, just as their risk profile has been worsening.

If we retrofit transactional activities to the prosperity curve (Fig. 1C), we can see how much prior “growth” has been inflated artificially.

The further introduction of segmental analysis – dividing output into essentials, capital investment and discretionary consumption – enables us see an emerging dynamic in which consumers’ ability to afford non-essential products and services is coming under relentless pressure.

What Fig. 1D does is to reveal to us those economic processes which are being experienced as the ‘cost of living crisis’. We’re at the start of a steep downwards incline, not just in the affordability of discretionaries, but also in the ability of the household sector to service its ever-growing mountain of financial commitments.

Meanwhile, and just as financial investment is increasing, capital investment – that’s to say, investment in the creation and replacement of productive capacity – is on a declining path.

 

Fig. 1

Where now?

Looking at our predicament, whether as description or as charts, a number of critical points become apparent.

First, the same financialization process which is creating a simulacrum of “growth” is driving debt and broader liabilities to a point at which vertigo sets in. A clear implication is that the “everything bubble” in asset prices must explode, and that decision-makers must adopt ever looser fiscal and monetary policies in an effort to keep the show on the road.

Analysis of the material economy, meanwhile, reveals a background process in which certain sectors – led by discretionaries, and by those over-invested in the supposedly-perpetual miracle of financialization – either contract or disappear.

Your guess is as good as mine as to whether the economy contracts gradually, or a financial collapse burns out the wiring linking the components of the material economy.

All we can really do is work out the pattern of stresses in the system, thereby trying to push the odds in directions favourable for ourselves.

It’s an old adage that ‘the most dangerous part of a car is the nut holding the steering wheel’.

Where decision-making is concerned, we can only hope that the arrival of materiality brings wisdom where the progression of financialization has brought folly.

 

Tim Morgan

COPING WITH THE SHOCK OF THE REAL

As 2023 draws to a close, I’d like to take this opportunity to thank everyone for their informed, constructive and courteous contributions to our debates over the past twelve months, as well as wishing you the very best for the Festive Season and the year ahead.

I don’t know what you’re hoping for in 2024, but I’d settle for a bit of old-fashioned reality. Like Alice in both of her famous adventures, we seem to have stumbled into a parallel world where nothing is quite what it seems.

The economy carries on growing, even though it isn’t. In this Wonderland that we’ve created out of whole cloth, debt doesn’t matter, creating money out of the ether isn’t inflationary, and we can borrow our way to prosperity whilst money-printing our way to financial sustainability.

Technology has abolished the laws of physics, and we can enhance our prosperity by reducing the density of the energy inputs that drive the economy. Carl Benz, Gottlieb Daimler, the Wright Brothers and Frank Whittle got it wrong when they decided to power their cars and aeroplanes with petroleum rather than windmills. W. Heath Robinson and Salvador Dalí painted reality much better than Rembrandt van Rijn and Nicholas Pocock.

Delusion may sometimes be preferable to reality, but reality, when it returns, tends to have sharp edges. In short, I have a nagging feeling that, when Alice steps back Through the Looking-Glass, she’s going to find that somebody has stolen most of the furniture. I don’t know how much longer we can sustain the illusions of the moment, but my sense is that the factual is waiting in the wings.

 

To solve or to deny?

If there’s a theme to this discussion, it’s the gulf, not so much between the real and the imaginary, but between knowing something and being willing to accept it. After all, a retreat into fantasy usually results from an unwillingness to see the world as it is.

The emergence of this gap between reality and perception isn’t all bad news, of course – it gives realists a competitive edge over fantasists. I’m not going to go into investment decisions, career options or political choices here, except to say that the realists have the odds stacked in their favour. Suffice it to say that challenge and opportunity are the different faces of the same coin.

In the real world that some of us still inhabit, there are proven techniques for problem-solving. First, we find out what the problem actually is. Then, we dismantle the problem into its constituent parts. If we follow this procedure, we usually find two kinds of solution, or a combination of both. One of these is to work around the difficulty and resolve it. The other is to adapt to those bits of the difficulty that we can’t resolve, and learn to live with them.

When these problem-solving techniques go wrong, it’s usually because we don’t like the explanations that we’re finding, and aren’t prepared to accept the solutions that present themselves. If this happens, the likelihood is that we’ll miss-define the problem, and rule out from consideration those solutions that might actually prove successful.

Though there are many other matters of concern in our material world, our two biggest challenges today are a faltering economy and a deteriorating natural environment.

How real are these problems? Well, when we’re taking on anywhere from $3 to $7 of new liabilities for each dollar of “growth”, have no proposed fixes that don’t involve either borrowing or money-printing, have commitments that we can’t possibly honour and an “everything bubble” in asset prices that’s destined to burst, then there’s a prima facie case that the economy is in very big trouble.

When global temperatures are rising, and are being accompanied by worsening floods, droughts, storms, heatwaves and agricultural disruption, then it’s reasonable to conclude that the environment, too, is in trouble.

This needn’t drive us into despair, but should urge us to think.

 

In search of definition

An objective approach to these conjoined economic and environmental challenges recognises energy as the factor common to both. Even the briefest interruption to the supply of energy would stop the economy in its tracks. Climate science has identified the burning of carbon fuels as a major contributory factor in environmental deterioration.

Energy is where our quest for explanations and solutions must start.

With this point established, the logical next step is to define how these various processes work. On this fundamental basis, the economy functions by using energy to access raw materials and convert them into products and services.

This is a creation-diffusion equation – at the same time that energy is used to convert raw materials into products, energy itself is converted from dense into diffuse forms.

Add in our penchant for the rapid disposal and replacement of products and this becomes a dissipative-landfill economic system. The outputs of the creative process, together with their raw materials and embedded energy, are jettisoned with almost indecent haste. The output of the thermal side of the equation is waste heat and, when fossil fuels are used as the dense inputs to the system, this waste heat contains climate-harming gases.

This tells us that there are two possible solutions to our environmental challenge, not one.

One of these is to change the form of dense energy inputs to the system, moving from climate-harming fossil fuels to less harmful alternatives.

But the other potential solution is to slow the creation-disposal-replacement cycle itself.

A rational society would be addressing both of these possible solutions, not just one of them – we’d be looking at alternatives to fossil fuels, but we’d also be giving constructive thought to behavioural change.

There can be no guarantee that we can effect a wholly successful transition from carbon fuels to cleaner alternatives. In fact, an economy powered by renewables is highly likely to be smaller than the fossil-powered economy of today.

Accordingly, we should at least be investigating the idea of slowing the creation-disposal-replacement cycle, seeking to get more value from the energy and other resources that we consume. Effective solutions to environmental degradation might very well involve doing both.

It’s perfectly possible, should we so choose, for us to put the brakes on the dissipative-landfill cycle of rapid resource extraction, product creation, disposal and replacement, and doing so needn’t, in and of itself, make us poorer.

We could step up our re-use of raw materials by reconfiguring products, with recycling designed into them from the outset. We could demand products that are capable of viable repair, and have longer design-lives. We could subsidise longevity as well as taxing landfill. We could introduce strengthened recycling credits into the tax system. We could further this strategy by marketing it effectively to consumers.

With the appropriate use of incentives as well as regulations, we could make a decelerated resource cycle profitable. Opportunities will undoubtedly exist for those who choose to ‘go with the flow’ of material reality rather than persisting with the easier (but time-limited) conventions of the past and present.

 

A self-selected blind-spot

Thus far, though, the dissipative-landfill, extraction-creation-disposal economic system has been almost entirely off-limits for debate. Whether our countries are fossil fuel producers or consumers, we’re agreed on not challenging the system itself.

We have opted to fight our very real environmental challenges with one hand tied behind our backs.

Even the most environmentally concerned haven’t spotted the duality of the challenge. In recent times, climate activists have vented their anger on the producers of oil, natural gas and coal. Whatever its merits may or may not be, this approach lets off scot-free businesses whose activities accelerate the disposal cycle. If you produce oil or gas, your head office is likely to become the target of vocal protest. But if you use energy from oil, gas or coal to manufacture throwaway products, there won’t be an angrily-worded placard in sight.

This, it should be stressed, isn’t an anti-corporate argument. Private enterprise is essential to a balanced economy. The opposite extreme, which is state control of everything, is something that no sensible person should desire. “If we’re so awful, we’re so bad”, sang a famous American musician in the 1980s, “go and try the nightlife in Leningrad”.

Rather, what we need is a differently-configured corporate sector, which really means that we need to shift the basis of incentives to favour quality, repairability, reusability and longevity.

I’m not so naïve as to suppose that the corporate sector is going to opt for cycle-slowing processes of its own volition, and neither do I imagine that our leadership cadres are going to undertake the recalibration of incentives that could promote and accelerate such a switch.

In any case, political leaders have been left far behind the curve of environmental and economic evolution, and still see no problems that can’t be fixed with a bucket of greenwash, breezy public optimism and a further recourse to borrowing. There’s something very bizarre about hopping on to a kerosene-powered jet to attend a pow-wow about global warming.

But the economy itself is already pushing us in a different direction. The global economy is in the process of inflecting from growth into contraction. No amount of waffle about the possibility of ‘infinite growth on a finite planet’ can change this reality. We can’t fix energy and resource depletion with money, any more than we can cure an ailing house-plant with a spanner. Energy-intensive necessities are already becoming costlier. Discretionary affordability is under the cosh.

Under these conditions and pressures, it’s perfectly possible that pricing trends, and changing patterns of consumer preference, could drive this constructive evolution.

To understand why this is happening, we need to go back to fundamentals.

 

Children at play

The development of the industrial economy followed directly from our discovery of the ability to harness the vast quantities of energy contained in fossil fuels.

From that point on we, collectively, started behaving like irresponsible youngsters let loose in a chocolate-factory. The transformative benefits of abundant low-cost energy came without limits or obligations. There were no adults in the room. Nobody stopped us from becoming fixated with the new and shiny. We were free to consume, reject, replace and pollute at will. As well as polluting the land and the seas, we’ve even taken to using space as a backyard dumping-ground.

There was, and remains, little or no likelihood that we would choose to turn aside from this reckless form of behaviour. But material parameters – those conditions which determine the boundaries of possibility within which we have freedom of choice – are already starting to impinge on our capacity for recklessness. The clue to this lies in a matter already noted – the density of available energy.

Fossil fuels are the densest forms of energy yet harnessed by society. We’re not ‘running out of’ fossil fuels, but their costs are rising, and their abundance no longer remains a given. Quite naturally, we’ve used lowest-cost resources first, leaving costlier alternatives for later. The typical new discovery or development is smaller, more remote or more technically challenging – that is to say, more expensive – than the one that it replaces.

As these costs – measured here as the Energy Cost of Energy, or ECoE – carry on rising, the ex-cost value of each unit of fossil fuel energy decreases. This material cost has already risen five-fold since 1980, and there’s no way of putting the genie of rising ECoEs back into the bottle.

If climate campaigners grasped this, they could reinforce their environmental advocacy with powerful economic arguments. Continued reliance on carbon energy might or might not destroy the environment, but relentless rises in the material costs of fossil fuels would certainly destroy the economy.

 

An awkward legacy

This is where the choice between reality and self-deception becomes critical. Where alternatives to fossil fuels are concerned, renewables seem to be the best options on the table. Scaling them upwards requires vast amounts of everything from steel and concrete to copper, lithium and cobalt. Accessing and processing these materials requires correspondingly vast amounts of energy, and this can only come from legacy fossil sources.

Far from being “stranded” and somehow ‘useless’, fossil fuel assets are the only resource that exists to make energy evolution possible. The question becomes one of the wisdom, or folly, with which we choose to employ this resource.

This energy legacy is finite, meaning that it has limiting characteristics. One of these is the energy value that remains, and the other is the limit set by the envelope of climatic tolerance.

Like any legacy, this comes with choices – we can blow it now, or invest it, in this case in renewables, and in changing the character of the economy. We can’t put the same gallon of petroleum into a vehicle and use it to extract minerals and build wind-turbines. But we can make that energy unit go further if we tame our penchant for disposal.

The snag with all of this, of course, is that the lesser density of wind and solar power means that they are going to provide a smaller net-of-cost input to the creative-dissipative process. To believe that the wonders of technology are going to overcome the handicap of lesser density is to suppose that technology can circumvent the laws of physics.

Because of their lesser energy density, renewables are going to need a proportionately larger infrastructure – that is to say, more input resources, meaning more energy – than fossil fuels in their heyday. The necessity of using legacy energy to develop, operate, maintain and replace renewable capacity is an umbilical link tying the ECoE costs of renewables to those of fossil fuels.

 

In conclusion

I don’t want to end this article – or 2023 – on a depressing note. Change brings opportunities as well as challenges. There’s a lot that we might like about a society with a decelerated extraction-disposal cycle. A financial crash has become inescapable, but will be the product of delusion, not the consequence of reality.

Where all of this leaves us is, undoubtedly, with hard choices. We can choose to pretend that everything will turn out fine if we whistle a cheerful ditty, ignore the realities of energy and physics, and rely on monetary fixes for material problems.

Alternatively, we can take a hard look at the fundamentals, which is what I’ve been endeavouring to do over the decade since Perfect Storm and Life After Growth were published, this site was created, and work on the SEEDS economic model began.

“Hard choices” sounds gloomy, but that needn’t be our sole conclusion as we head into 2024. The economy is changing, with global material prosperity inflecting and the costs of energy-intensive necessities continuing to rise. Accordingly, the affordability of discretionary (non-essential) products and services faces ongoing compression.

The concept of involuntary economic de-growth has been shifting inexorably from left-field prophecy towards real-world reality.

But spooks imagined in the darkness can become less frightening when we examine them in the light. There’s no reason why we shouldn’t respond constructively to this challenge. Creation and rapid disposal is a choice, not the diktat of Holy Writ, and alternatives can be profitable as well as sustainable – especially for those who get there first.

 

Tim Morgan